Why Financial Statements Matter
Every publicly traded company tells its financial story through three documents: the income statement, the balance sheet, and the cash flow statement. Together, they reveal whether a business is growing, profitable, financially stable, and generating real cash. Reading these statements is the foundation of fundamental analysis and the single most reliable way to separate quality companies from risky ones.
You do not need an accounting degree to extract meaningful insights. Knowing where to look and what patterns to watch for will put you ahead of the majority of retail investors who rely solely on stock price charts or social media tips.
The Income Statement
The income statement (also called the profit and loss statement, or P&L) shows how much money the company earned and spent over a specific period, typically a quarter or a year. It answers the fundamental question: is this business profitable?
Key Metric
Revenue (Top Line)
Total income from the company's core business operations before any expenses are deducted. Revenue growth is the primary indicator of whether demand for the company's products or services is increasing. Consistent revenue growth over multiple years suggests a healthy business with expanding market share.
Key Metric
Gross Profit & Gross Margin
Gross profit is revenue minus the direct cost of producing goods or services (cost of goods sold, or COGS). Gross margin is gross profit divided by revenue, expressed as a percentage. A rising gross margin means the company is becoming more efficient or gaining pricing power. Software companies often have gross margins above 70%, while retailers may operate at 25-35%.
Key Metric
Net Income (Bottom Line)
The final profit after all expenses, taxes, interest, and depreciation are subtracted from revenue. This is the number used to calculate earnings per share (EPS). Net income can be distorted by one-time items, so always check whether any unusual charges or gains are included in the figure.
When reading the income statement, focus on trends over multiple periods rather than a single quarter. Is revenue growing? Are margins expanding or contracting? Is the company converting more of its revenue into profit over time? These trajectory questions matter more than absolute numbers.
The Balance Sheet
The balance sheet is a snapshot of what the company owns (assets), what it owes (liabilities), and what belongs to shareholders (equity) at a specific point in time. It answers the question: is this company financially healthy?
Assets = Liabilities + Shareholders' Equity
This equation must always balance. If it does not, something is wrong with the filing.
- Current assets include cash, accounts receivable, and inventory -- things the company can convert to cash within a year. A healthy current ratio (current assets divided by current liabilities) above 1.5 indicates the company can comfortably cover its short-term obligations.
- Long-term debt is the company's borrowing that extends beyond one year. Compare total debt to equity (the debt-to-equity ratio) to gauge financial leverage. A ratio above 2.0 may signal excessive borrowing, though acceptable levels vary by industry.
- Shareholders' equity represents the book value of the company -- what would theoretically remain if all assets were sold and all debts paid. Growing equity over time is a positive sign; declining equity can indicate the company is burning through its net worth.
The Cash Flow Statement
The cash flow statement tracks the actual movement of cash in and out of the business. It is arguably the most important of the three statements because cash is harder to manipulate than accounting profits. A company can report strong net income while bleeding cash, which eventually leads to trouble.
- Operating cash flow (OCF) shows cash generated from the core business. This should be consistently positive and ideally growing. If a company reports high net income but negative operating cash flow, it is a red flag -- profits may exist on paper but not in the bank account.
- Capital expenditures (CapEx) represent spending on property, equipment, and other long-term assets. Subtracting CapEx from operating cash flow gives you free cash flow (FCF), the cash available for dividends, buybacks, debt repayment, or acquisitions.
- Financing cash flow shows cash from issuing or repaying debt, issuing or buying back stock, and paying dividends. A company consistently raising capital through new share issuances dilutes existing shareholders, while one that buys back shares is returning value.
Red Flags to Watch For
Revenue growing but cash flow declining. A debt-to-equity ratio spiking suddenly. Accounts receivable growing much faster than revenue (customers may not be paying). Inventory ballooning without corresponding sales growth (products may not be selling). Frequent "one-time" charges that appear every year. Any of these patterns warrants deeper investigation before investing.
Common Mistakes
- Only reading the income statement. Net income looks great, but the balance sheet shows crushing debt and the cash flow statement reveals negative free cash flow. All three statements must tell a consistent story.
- Ignoring the notes and footnotes. Companies disclose critical information in the footnotes of their filings -- off-balance-sheet liabilities, pending lawsuits, revenue recognition changes. Skipping the footnotes means missing context that can completely change your thesis.
- Comparing companies of different sizes. Use ratios and margins (percentages) rather than absolute dollar amounts when comparing companies. A $10 billion company will naturally have larger revenues than a $500 million company, but the smaller one may be more profitable on a percentage basis.
- Looking at a single period. One great quarter does not make a great company. Review at least three to five years of financial data to identify trends, cyclicality, and consistency.
How Journely Reads Financial Statements for You
When you ask Journely to analyze a company, the AI pulls data from all three financial statements and computes key ratios automatically: gross margin, operating margin, debt-to-equity, current ratio, free cash flow yield, and return on equity, among others. It compares these metrics to industry averages and the company's own historical performance.
Journely highlights any red flags -- deteriorating margins, cash flow that diverges from net income, unusual spikes in debt -- and explains what they might mean for the investment thesis. You get the equivalent of a professional analyst's financial review, delivered in plain language within seconds.